Beat\'em Up Corporation issued $20 million in debt ten years ago to Finance its

Question

Beat'em Up Corporation issued $20 million in debt ten years ago to Finance its factory construction. The debt allows Beat'em Up to make interest-only payments at a 7 percent interest rate, paid semiannually for 30 years. Debt issued today would carry only 6 percent interest rate. The company's CKO is considering whether or not to issue new debt (for 20 years) to pay off the old debt. To pay off the old debt early, the company would have to pay a penalty totaling $1.4 million to its debt holders. To issue new debt, the firm would have to pay investment bankers a fee of $1.2 million. Should the CFO replace the old debt with new debt?

Explanation / Answer

Since NPV of savings is less than initial cost, CFO should note replace the old bond with new debt.

Working

Calculation of net initial outflow Repayment of old Bond -20 Early payment Penalty cost -1.4 Proceeds from issue of new bond 20 Investment Banker fee- New issue -1.2 Initial Outflow -2.6 Annual Saving in interest: 20*(7%-6%) 0.2 Semi Annual Saving in interest (0.2/2) 0.1 PV= Semiannual saving*PVIFA(rate,perod) PV=0.1*(PVIFA 6%/2, 20years*2) PV=0.1*(PVIFA 3%, 40) PV of Savings = 0.1*23.1148 2.31148 NPV= 2.31148- 2.6 -0.28852

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